Macro: Sandcastle economics
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Copper signals to stocks that all's not well
Ole Hansen
Head of Commodity Strategy
Summary: The short-term outlook for HG Copper has deteriorated this week following unexpectedly weak readings on manufacturing activity in China and the United States, the world's two biggest consumers of the industrial metal.
Copper, which is widely used as a conductor of heat and electricity, dropped almost 3% yesterday – the biggest fall since last August – to a ten-week low of $2.777/lb, close to its 200-day moving average. The forecast for tight supply, the continued move towards electrification, combined with infrastructure projects, is likely to provide a long-term support for copper. In the short term, however, the focus will primarily be on finding support with $2.717 representing a key line in a sand below $2.777/lb as mentioned.
The range-bound nature of the market since February has left many speculative investors sidelined with the hedge fund net position not swaying much away from neutral during this time. The renewed downside momentum is likely to have attracted some additional length to the short side and those recently established short positions will now be watching closely the above mentioned support levels for signs of an even deeper sell-off.
Apart from the recent dollar strength, which during the latter part of April reduced the appeal for metals, both precious and industrial, it was the slowdown in manufacturing activity in both US and China that did most of the damage. The drop in the US ISM manufacturing index for April was particularly aggressive as it dropped to the lowest level since October 2016. While still in expansionary territory above 50, the broad-based declines in new orders, new export orders and production suggest a further cooling which contradicts but also explains why the market failed to get excited about the Q1 GDP reading last Friday.
These and other recent data from the world’s two biggest economies also highlight why the market is increasingly expecting that a trade deal between the two countries will be reached sooner rather than later. A deal will undoubtedly create a lot of market-friendly headlines but we see an overriding risk that it could by over-hyped with weak control mechanisms put in place to police a deal.
These and other recent data from the world’s two biggest economies also highlight why the market is increasingly expecting that a trade deal between the two countries will be reached sooner rather than later. A deal will undoubtedly create a lot of market-friendly headlines but we see an overriding risk that it could by over-hyped with weak control mechanisms put in place to police a deal.
Industrial metals, as seen through the Bloomberg Industrial Metal Index, have been tracking the developments in the US stock market relatively closely since last October. A dislocation, however, has occurred during April and it raises the question of who is right. Bearing in mind the compressed levels of volatility and elevated speculation in lower volatility as seen through the Cboe VIX futures we can potentially look forward to a bumpy stock market ride ahead of the annual holiday season between July and August.
Where is the potential support coming from?
While demand may struggle to pick up amid the continued worries about weaker economic growth, the physical market is widely expected to remain tight during the coming years. Inventory levels at exchange-monitored warehouses are currently 442,000 tons, some 24% below the three-year average. The forecast for tight supply the continued move towards electrification combined with infrastructure projects is likely to provide a long-term support for copper.
Just last week in the US, the Democratic congressional leaders emerged from a meeting at the White House and announced that President Trump had agree to pursue a $2 trillion infrastructure plan to upgrade the nation’s highways, railroads, bridges and broadband. The big question, however, remains who should pay for this initiative. Not least considering how the US has become increasingly maxed out on debt and tax cuts which so far have failed to boost the economy.
While demand may struggle to pick up amid the continued worries about weaker economic growth, the physical market is widely expected to remain tight during the coming years. Inventory levels at exchange-monitored warehouses are currently 442,000 tons, some 24% below the three-year average. The forecast for tight supply the continued move towards electrification combined with infrastructure projects is likely to provide a long-term support for copper.
Just last week in the US, the Democratic congressional leaders emerged from a meeting at the White House and announced that President Trump had agree to pursue a $2 trillion infrastructure plan to upgrade the nation’s highways, railroads, bridges and broadband. The big question, however, remains who should pay for this initiative. Not least considering how the US has become increasingly maxed out on debt and tax cuts which so far have failed to boost the economy.
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